Europe Takes an Important Step Forward on Banking

The political agreement reached early on December 13 by Europe's finance ministers makes it highly likely that legislation establishing a Single Supervisory Mechanism (SSM) with the European Central Bank (ECB) at its center will be enacted in March 2013. This is a big European success, high up on what was the range of possible outcomes.

Some features of the agreement and comments:

It respects the outlines and timetables set in the two declarations of EU heads of state and government of June 29 and October 18. For once, European policymakers delivered on their promises, and did so on time.

From press reports, the ECB will directly supervise all banks above €30 billion in total assets, as well as some smaller banks, and will have some form of backseat authority on all other smaller ones. (What that authority exactly consists of is still not entirely clear, including the crucial question of direct access to bank-specific information.) This covers not only large banks but also medium-sized ones, in total probably somewhere between 75 and 85 percent of the system's total assets. The ECB recently estimated that 70 percent of euro area banking assets were in banks above €40 billion in total assets, so with the threshold at €30 billion and a few additional small banks included, the share must be somewhat higher. The exclusion of small banks is not really justifiable from a technical or analytical perspective. But it was also arguably unavoidable given Germany's central role in the decision process and its unique political and banking structures, which grant enormous political influence to the savings banks. (This aspect is developed in my latest policy brief, pages 5–6.)

The legal basis, Article 127(6) of the Treaty on the Functioning of the European Union (TFEU), is reasonably robust even though it was clearly not drafted with this outcome in mind.

The agreement seems to go almost as far as possible in granting equal rights to non-euro areacountries that may wish to participate. This is important as it potentially prevents deepening the divide between euro and non-euro countries in the European Union. The United Kingdom, Sweden, and the Czech Republic have said they would not participate. The other seven, including most prominently Poland and Denmark, have not yet made their position clear. Denmark can be expected to not make up its mind rapidly, but a quick decision might be expected from Poland and other Central and Eastern European countries.

From press reports it appears that the governance arrangements will be somewhat better than initially envisaged, with a compact steering committee in charge that may be able to drive better-quality decision making.

Compared to the European Commission's initial plans, the implementation timetable is slightly delayed. The ECB would acquire full supervisory authority only by March 2014 if not later. Given the German election cycle, this is not much delay in practice, however. Alas relatively little action is to be expected next year in a baseline scenario (see also below on bank resolution).

The reform of the European Banking Authority (EBA) was eventually aligned with the UK position of requiring a majority of member states that do not participate in the SSM for EBA decisions. This is awkward, to say the least. It creates additional rights for countries that decide not to participate in a major EU initiative. However, there was no obvious, clearly superior option available in the short timeframe of decision making—and the United Kingdom has a veto on the whole process under Article 127(6), which gave it a strong negotiating position. So perhaps this unsatisfactory outcome was inevitable. In any case, a comprehensive review of the EBA is planned in 2014, so this may be seen as a temporary fix rather than a permanent arrangement.

The only significant remaining hurdle is for this compromise to obtain approval from the European Parliament (EP). Technically there are two texts (called regulations in the EU jargon, but they are really EU laws), one for the SSM and the other for EBA reform. The EP cannot block the SSM regulation because its role is only consultative under article 127(6). But it has co-decision powers on the EBA regulation. Thus in principle it can block the whole process, as the United Kingdom would probably veto the SSM if the deal on EBA was substantially altered. In practice, however, the EP will probably not want to obstruct the passage of what is assuredly one of the most constructive EU policy initiatives since the start of the crisis more than five years ago. It should seek being granted more direct accountability from the SSM, e.g., an EP veto on appointments of members of the ECB's newly created "Supervisory Board" other than the heads of national authorities who participate ex officio. This would be in line with the European Union's proclaimed aim that "further integration of policy making and greater pooling of competences must be accompanied by a commensurate involvement of the European Parliament" (point 14 of the December 14 Council conclusions [PDF]).

Of course, this is only about supervision. None of it directly impacts crisis resolution or the cleaning up of Europe's ailing banking system. But the discussion of how to envisage bank resolution, including the role of the European Stability Mechanism (ESM) to directly recapitalize weak banks, can now start. This discussion is bound to be long and difficult. An eventual agreement may have to be delayed until after the late-2013 German general election anyway. The December 14 Council conclusions include oddly complicated language on this (points 8, 10, and 11). It appears there will be three steps: first, an "operational framework" for direct bank recapitalizations by the ESM "should be agreed as soon as possible in the first semester 2013;" second, the currently discussed European legislations on national bank resolution schemes (Recovery and Resolution Directive) and deposit insurance (Deposit Guarantee Scheme Directive) should be finalized "before June 2013; the Council for its part should reach agreement by the end of March 2013"; and third but not least, "the [European] Commission will submit in the course of 2013 a proposal for a single resolution mechanism for Member States participating in the SSM […] with the intention of adopting it during the current parliamentary cycle," i.e., in early 2014. But point 10 also indicates, in line with earlier Summit conclusions, that the ESM will only be allowed to recapitalize banks directly "when an effective supervisory mechanism is established," which according to this week's decisions will not be before March 2014. Thus, the baseline scenario seems to be one in which ESM intervention in the banking sector is delayed until after the adoption of the "single resolution mechanism," which itself is likely to stop well short of a single resolution authority given the lack of corresponding provisions in the European treaties. (This point will be developed in a forthcoming blog post.) If this is confirmed, 2013 will be another year of delay for the decisive action necessary to restore trust in the European banking system and put an end to its current creeping zombification [PDF].

There is still zero appetite to discuss a European deposit insurance framework beyond the harmonization of national schemes, even though it is arguably a necessary component of a fully fledged banking union. But this reluctance is understandable as long as the debate on fiscal union is stalled. It is not an urgent topic—at least as long as no retail bank run happens in the euro area. Fingers permanently crossed on this.

Once again, centralized supervision is only the first step on the long and winding road towards European banking union. But the fact that this step is now essentially confirmed is almost unqualified good news.